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Will FireEye Inc Ever Turn a Profit?

Is this cybersecurity company about to sacrifice long-term growth for short-term profitability?

Shares of FireEye(NASDAQ:FEYE) plunged 17% on Aug. 4 after the cybersecurity firm reported weaker-than-expected revenue and billings growth during its second quarter. Revenue rose 19% year-over-year to $175.05 million, missing estimates by $6.6 million and marking its slowest growth rate since its IPO in 2013. Billings, which reflect future contract revenues, rose just 10% to $196.4 million, missing expectations by $13.2 million.

FireEye's GAAP net loss widened from $133.6 million a year ago to $139.3 million, or $0.86 per share. On a non-GAAP basis, which excludes stock based compensation and other charges, its net loss slightly narrowed from $62.6 million to $52.7 million, or $0.33 per share -- which still beat expectations by six cents.

Image source: Getty Images.

CEO Kevin Mandia, who took over the top position in June, admitted that the company had "much work to do," but that it was "taking additional steps to achieve balanced growth and profitability." Those steps include restructuring plans to reduce the company's annual expenses by about $80 million, and Mandia believes that $20 million in cuts during the fourth quarter will help it achieve non-GAAP profitability during that period. That's a bold statement, but I have serious doubts that FireEye can achieve that lofty goal.

Can FireEye break even?

Mandia and CFO Michael Berry believe that FireEye can achieve profitability by cutting infrastructure costs, discretionary spending, and its employee headcount. But there are a few huge hurdles in the way.

First, FireEye expects its revenue to rise 15%-17% and for billings to grow 5%-7% in 2016. That compares very poorly to its 46% growth in revenue and 35% growth in billings in 2015. Second, it projects a non-GAAP net loss of $1.28-$1.32 for the year, compared to a net loss of $1.61 in 2015.

If FireEye couldn't achieve non-GAAP profitability while it was posting 46% sales growth, how can it achieve profitability with 15%-17% growth? FireEye believes that cutting its operating expenses by 9% from 2015 levels will do the trick, but the margins tell a different story. FireEye finished 2015 with a non-GAAP operating margin of negative 38%, and it sees that figure narrowing to negative 26%-28% for 2016. Boosting that figure to profitable levels will require much more than a 9% year-over-year reduction in operating expenses -- especially as revenue and billings growth slow to a crawl.

Meanwhile, reducing FireEye's workforce and infrastructure costs during a top line slowdown could hurt its ability to grow, especially with bigger competitors like Cisco(NASDAQ:CSCO), Check Point, and Palo Alto Networks (NYSE:PANW) all expanding into the same threat prevention space.

Reducing stock-based compensation could boost profits

The outlook for FireEye looks bleak, but laying off employees will finally reduce its stock-based compensation, which rose 14% to $121.5 million during the first half of 2016 and gobbled up 35% of its revenue. Many small tech companies with low cash flows rely heavily on stock-based compensation, but FireEye's big bonuses are clearly weighing down its GAAP profitability and depleting its cash reserves.

FireEye's cash and equivalents plunged from $402 million at the end of 2015 to just $184 million at the end of the second quarter -- indicating that it might need to rely on more share-diluting secondary or convertible debt offerings to raise cash.

Its industry peer CyberArk(NASDAQ:CYBR), for example, only paid out 7% of its revenue as stock-based compensation last quarter, and remains profitable on both a non-GAAP and GAAP basis. CyberArk's cash and equivalents position rose almost 2% sequentially during the quarter.

But the real problem with FireEye isn't profitability

By talking about cost reductions and profit goals, Mandia is pulling investors' attention away from FireEye's core problem -- slowing demand for its threat prevention services. The market is a crowded one, and many companies which monitor the network perimeter -- including big IT firms like IBM, next-gen firewall providers like Palo Alto, and networking giants like Cisco -- now offer bundled threat prevention solutions.

FireEye's shift from on-site appliances to its cloud-based FaaS (FireEye as a Service) subscription platform doesn't seem efficient enough to counter those threats. By downsizing at this critical time, I believe that FireEye could be marginalized by these larger players. Revenue and billings growth will likely slow down over the next few quarters, which could make it even harder for FireEye to break even.

I doubt that FireEye will turn a profit anytime soon, but I don't think that should be its priority -- it should invest in widening its moat against its bigger rivals and accelerate the growth of FaaS, even if it means issuing more stock or taking on debt.

Leo Sun owns shares of Cisco Systems and CyberArk Software. The Motley Fool owns shares of and recommends Check Point Software Technologies and FireEye. The Motley Fool recommends Cisco Systems, CyberArk Software, and Palo Alto Networks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Author

Leo is a Tech and Consumer Goods Specialist who has covered the crossroads of Wall Street and Silicon Valley since 2012. His wheelhouse includes cloud, IoT, analytics, telecom, and gaming related businesses. Follow him on Twitter for more updates!